Monthly Archives: June 2009

28th June We need to change our saving habits

I watched a programme this evening about the Bernard Madoff scandal.

Of everything that has happened in the last 2 years, this event makes me the angriest. Apart from the fact that the man was a total degenerate, intent on robbing everyone he came into contact with, it also exposed the most serious, fundamental flaw at the heart of the financial system; namely how the savings of ordinary individuals are put to work.

Leaving aside the failure of the SEC to act on information they were given a decade ago that Madoff’s fund was probably a Ponzi scheme and also ignoring the number of so-called professional or sophisticated investors who were duped, the most glaring insight I gained from the programme is how misplaced our trust has been in the people who were meant to be custodians of our wealth.

While Madoff was a criminal this case typifies a wider issue in how our savings are managed and how we make decisions regarding their placement.

I feel a great deal of pity for the people who lost their life savings, but I also wonder how intelligent people, who had saved +$1,000,000 did not see the danger in placing their entire retirement funds in one institution. I think I have mentioned before that one thing the financial industry has been fantastic at in the last 100 years is to recover from a self-inflicted crisis whilst maintaining the pretense that there is some kind of alchemy in the work they do.

Of course most of this is total rubbish as we are witnessing yet again. For the most part buying a simple tracker fund will serve the long term interests of the majority of ordinary private investors. Even so such is the aura of mysticism around “finance” that the majority of people are put off learning basic good practice. This has to change.

22nd June The Byzantine approach to regulation

I find myself wondering sometimes, whether or not we are living through the end of days of Western dominance of global affairs. This might sound a touch dramatic, but I can’t help but feel we are drowning in a sea of terrible decisions, but seem blissfully unaware of what is happening. We face great challenges, but our bureaucracy is ill-prepared to respond to these effectively.

News last week was dominated by the pre-announcements concerning Obama’s plans for the new regulatory system to govern the financial sector in the US. Although light on detail, what leapt out at me was that there will now be 6 (yes 6!) different regulating bodies; none of whom will take overall responsibility.

So what will happen when things next go wrong? It will be no-one’s fault of course!

Although there were positive points to the plan, such as increasing capital reserve requirements substantially, surely we have learned from the current crisis that the lack of accountability sowed the seeds for reckless and irresponsible behaviour.

Let me give one example where issues might (almost certainly will) occur. If I understood this correctly a distinction has been made between “standardised” and “customised” derivatives. Leaving to one side what determines a “standardised” derivative from a “customised” derivative, this part of the plan is begging for trouble.

Once the new regime comes into force, how long will it be before there is a rush to create “customised” derivatives? While playing within the newly defined rules this gives the banks a sanctioned area to “innovate”, without recourse. Am I the only one who sees the potential for Credit Crisis II in this?

There is a very basic principle at stake here; an excessively complex, yet powerful, failed system will not be revived by a complex set of new rules. Complex problems require simple solutions.

OK so what would I have done differently, you are probably asking yourself? This is a very difficult question to answer, but I am starting to reach the conclusion that the answer lies in clamping down on “financial innovation”.

I fear that the Credit Crisis has shown us the market will not be allowed to work on its own. Free-market purists will argue that in fact the market did work perfectly well, hence the crash, but the truth is the system wasn’t allowed to fail, hence the bailouts.

Time will still tell whether or not this strategy has worked, but for the time being, Governments are providing the backstop, preventing total meltdown. A critical feature of a free market economy was apparently the economic good that investment banks were able to stimulate through intelligent innovation. Although it is difficult to find any analysis of the last 2 years, which does not shatter this view, there seems to be an obsession with returning to how things were amongst our leaders.

I absolutely understand the necessity for futures and options in certain markets. Used properly they help businesses and individuals manage risks associated with time sensitive deliveries of real world goods. Innovative funding packages can also had a great deal of value to human enterprise and enable great projects to happen.

However when left unchecked we have all witnessed the dark side of excessive use of “financial innovation” — huge bonuses paid to undeserving executives, traders and sales people, immense value destruction, sharp rises in unemployment etc. etc.

Lord Turner, Chair of the FSA, was absolutely right when he said that a lot of the products created in the previous decade had done nothing to “improve the sum total of human existence”. So surely the answer therefore is not to try and accommodate this behaviour, but actually to curb it.

I started off this piece expressing concern about our future. While there are definite parallels between the ailing Byzantine Empire and our own troubled systems, the truth is I am actually quite positive for our long term future. While Western dominance will wane, I don’t actually believe this will be a bad thing for the Planet.

To end let us not forget our much-valued Chancellor’s response to the need for reform. Apparently we don’t need it! The decisions taken by the Government at the start of their term were sound. Anyone would think there is an election coming up.

15th June Now the CBI is predicting an end to the recession

On the way into work this morning I heard a report that the CBI is now predicting an end to the recession. Apparently we are due to see a return to growth in early 2010.

Bailouts and fiscal stimuli apart, I just can’t see the likelihood of this scenario. Admittedly the CBI’s forecast is for negligible growth during 2010, so statistical variance does give this set of predictions a get out of jail free card.

I know I keep saying this, but consumer spending underpins our economy. Consumer spending is wholly reliant on employment (and house prices, it could be argued). So far in this recession job losses have been almost exclusively in the private sector, with financial services especially hard hit. This has caused a substantial decline in tax revenue (10% by the latest estimate).

Prior to the Credit Crisis financial services accounted for 10.1% of UK GDP, so this sector’s importance as a generator of growth cannot be underestimated. Nobody expects financial services to return to its prior prominence in the near future.

So where is the growth going to come from?

When we consider the parallel decline in manufacturing output the outlook worsens.

And that is before we even start to consider the next Government’s Augean-like task of resolving the public sector deficit. With a heavily unionised workforce, outdated working practices and inflated wage structures, unwinding a decade of inefficiency is going to cause a great deal of unrest.

Once public sector jobs start to go, then the real pain will start to be felt. The sooner we have a General Election and can start this process the better.

In the meantime genuine recovery in 2010 remains a false hope for me.

11th June Apparently the recession has ended!

The Independent today reported that National Institute of Economic and Social Research has forecast that the British economy hit a bottom in March. April and May’s anemic growth of 0.2% and 0.1% apparently further supports this view.

This report is extremely confusing. The NIESR has a strong reputation as an independent body of economic researchers and forecasters. It was only a month ago that they released a much bleaker view of the economy.

I appreciate the importance of maintaining a flexible view on economic conditions, but have things really improved so much in the last 4 weeks that we can now credibly believe a call that the bottom has been reached?

Personally I can’t.

My view of the UK economy remains the same. We are in a state of limbo. Until there is a General Election no serious efforts can be made to reform public sector spending. Time also needs to be given to establish whether or not the policy of Quantitative Easing has been complete folly or a work of genius.

On the latter there are a lot of worrying signs that the international bond market is reaching saturation point for UK (and US) Government debt. However there is still a chance (albeit an outside one in my opinion) that the worst might not happen on this front, so a wait and see approach is probably advisable.

However with respect to the former item, public sector spending, there can be no doubt in any one’s mind that this has to be slashed. The huge deficit this country is running is undesirable and unsustainable.

There is no chance that the Labour Government will make cuts before the General Election. Public sector employment is about all they can cling onto if they are to stand any chance of reversing the increasingly damaging trend of electoral thrashings they are incurring. This means that we are not likely to see a spike in unemployment and the related economic implications for at least another twelve months. The question is though what will happen then?

Much of the debate at the moment is to whether or not public sector spending cuts are going to happen. The exchanges in yesterday’s Prime Minister’s Questions were a classic example of Labour denying that they will make such cuts whilst the Tories desperately tried to avoid admitting their plans.

I find the level of electioneering on both sides of the House very disappointing. The debate is not about whether or not cuts will happen, but to what extent cuts are an absolute necessity. In addition to this we need a dialogue on what impact these cuts will have on our ailing economy and how we can prepare ourselves to cope with their impact.

This has to be the defining issue facing our country for the next 10 years.

Calling an end to the recession at this point has to be nonsense. So far job losses have been almost exclusively in the private sector. Once public sector employees start to face pay cuts and redundancy then our predicament is bound to become a lot more perilous.

Yet still Sterling rallies….?!

10th June Has anything been learned?

I know I have been quiet in the last couple of weeks, but I have been trying to make sense of what is happening. While optimism has abounded, I haven’t been able to shake a deep-rooted sense of pessimism. Judging by the ongoing lack of volume in stocks it appears that this view is shared, if not openly admitted or acknowledged.

There are still huge structural problems facing our economy, not least the level of personal, public and corporate debt, but what has bothered me most is that nothing has been done to challenge the pervasive culture of entitlement present in our society.

Selfish accumulation of wealth and consumption at any cost is so destructive. The root causes of the Credit Crisis were undoubtedly found in the personal attitudes of those in positions of power. This point has been missed by our “leaders” and there are worrying signs that the party is going to carry on for those in positions of responsibility.

In spite of all of the bailouts, recriminations over levels of pay and uncertainty in the viability of the economy the status quo has been preserved. In the last week we have learned that;

While there have been some notable examples of leaders being brought to account (MPs and the Shell shareholder revolt), not enough has been done to cure the system of the greed that has infected it.

I have said this before, but unless we experience a fundamental reappraisal of personal attitudes, this economic crisis has the potential to go on for a very long time.